Sunday, March 5, 2017

US Equity and Economic Review: Great Fundamentals and Technicals

On Tuesday, the BEA released the second estimate of 4Q GDP. While the 1.9% headline number was uninspiring, the 6.6% decline in exports was the primary cause. Personal consumption expenditures rose 3%, helped by a very impressive 11.5% rise in durable goods purchases. A 9% uptick in residential building along with a 1.9 boost in equipment investment contributed to overall investment increasing 9%. As this following graph shows, the huge Q/Q drop in exports more than offset the positive contributions from personal spending and investment:

Also, note that an export decline of this magnitude only occurred in 3 other quarters over the last 5 years.

The BEA also released personal income numbers this week. The chained disposable income and personal consumption expenditures both declined. However, this is only 1 month of data in an otherwise bullish data series. And the 1-month contraction stands in stark contrast with the Conference Board’s consumer confidence number rising to a 15-year high.

Durable goods increased 1.8%, but transport orders were the sole reason for the increase. The ex-transport number was -.2. But on the plus side, non-defense capital goods orders rose an impressive 3.6%, which continues this data series’ recent uptick in activity:

However, the durable goods data series continues its move sideways between the 220 and 240 million level, where it’s been for the last 4 years:

Finally, ISM released their manufacturing and service numbers this month. The manufacturing number increased 1.7 to 57.7; new orders rose 4.7 while production increased 1.5. Prices, however, are a still elevated 68. The service sector headline number increased 1.1 to 57.6 with both new orders and employment growing. Both data series contain a positive anecdotal comments section. The combined reading of both numbers is for continued growth and perhaps some acceleration in business activity in the next few months.

Economic Conclusion: this weeks’ news was positive. The ISM manufacturing and service sector readings were the week’s strongest news; they indicate U.S. business is doing well. Although the 4Q GDP headline number was disappointing, the internals were far less so. Best of all, U.S. business is spending on investment again, which is a welcome development. Durable goods orders continue to move sideways – which continues its three year holding-pattern trajectory. While we’d prefer to see this statistic increase, the 3-year printing between $220 and $240 million still indicates the economy is moderately healthy.

Market Overview: the market has performed very well since the election:

The market’s total increase is about 15% -- which would be a great return for an entire year. Better still, the chart is technically sound. There’s a first rally from 207-227, following by a multiple month consolidation between 222-230. This allowed the market to consolidate gains before moving higher in early February. There are, as always, counter-arguments that the rally is near its end, which are clear on the weekly chart:

The percentage of stocks about the 200 and 50-day EMAs are near multiple year highs while the MACD and RSI are both over-extended.

The post-election rally is occurring against a solid and improving economic backdrop. Business and consumer confidence rose after the election. Business owners believe the new administration will be very pro-business, with an agenda to lower taxes and regulations. Consumers also believe Trump will be positive for the economy. Just as importantly, 4Q corporate earnings – the mother’s milk of stock valuations – were very positive:

As of Wednesday, March 1st, we have seen Q4 results from 484 S&P 500 members or 98.7% of the index’s total membership. Total earnings for these 484 index members are up +7.4% on +4.9% higher revenues, with 68.4% beating EPS estimates and 54.1% coming ahead of top-line expectations. The proportion of companies beating both EPS and revenue estimates is 40.3%.

And while earnings have been positive, the market remains expensive, with a high current and forward PE ratio.

So – that does this mean going forward? As we have been for the last 18-24 months, the market is between growing earnings and an expanding economy on one hand and an expensive valuation on the other.